Q. I am 61 and getting ready to retire in a couple of months when I turn 62 and can draw my Social Security. It doesn’t appear I will ever need to touch my TSP or my deceased husband’s IRAs. I was planning to leave those accounts to my children and grandchildren, however, a co-worker told me that I have to spend my TSP when I get older. Is that true? Can the government make me spend my retirement savings even if I don’t need it?
A. Sorry to say, your co-worker is correct. It’s called “Required Minimum Distributions,” or RMD for short. Be aware, RMD carries one the most excruciating penalties (for non-compliance) allowed within the U.S. tax code. The RMD requires a proverbial “pound of flesh” for those who forget, miscalculate or just ignore it.
So, what is the RMD rule? In simple terms – The year following your 70 ½ birthday (and every following year) you will be required to withdraw a percentage out of your “qualified” accounts. Each year, this percentage is determined by the IRS. Qualified accounts include – TSP, traditional IRAs, 401ks, etc.… (not ROTH).
Even inherited IRAs are subject to the RMD draconian punishments. So, when your husband would have turned 70 ½, the same rules will apply to his retirement accounts as well.
So, how bad are the non-compliance RMD penalties?
The tax penalty for not withdrawing the correct amount of RMD: up to 50% for every dollar that should have been withdrawn, that wasn’t.
Example: You are instructed to withdraw $8,000 from your qualified accounts due to RMD requirements. You only withdraw $5,000 from your qualified accounts, on time. That leaves $3,000 short of meeting your RMD. $3,000 x 50% = $1,500 penalty.
The reason for the over-the-top penalties?
Ensured compliance! Keep in mind, TSP, IRAs, 401ks and the like, have never been taxed. So, while the law makers have allowed for long-term, tax-deferred savings, they DO eventually want their cut. When you withdraw money from these accounts, that withdrawn money is then no longer tax protected. In its unprotected state, it gets added to your taxable income for the year, thus creating a potentially greater tax liability owed to the IRS.
While I know it was not your original plan, the annual RMD percentages usually aren’t substantial enough to avoid considering the aforementioned consequences. RMD is a percentage of all “qualified” retirement accounts that a tax-payer has developed in their lifetime. It starts off (at 70 ½) the first year (usually) between 3-4%, with periodic and relatively small increases throughout your life.
All may not be lost – If you are sure you won’t need your TSP and IRAs, and wish only to leave those assets to family, talk to your financial planner about setting up a wealth transfer strategy. There are approaches available that may provide you with the legacy you seek (perhaps even more), lower tax consequences for your family and full adherence to RMD rules.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. Investing involves risks, including the loss of principal. No strategy assures success or protects against loss.